Year End Tax Planning Help-Your Corporation

A greeting to you all my friends, it is time to write another year end tax planning article. What shall we discuss? What can I tell you all that will offer some sort of financial revelation helping with both your income tax and strategic financial management?

Well, times are difficult but some of you might still be in need of some practical tax planning. How about a C corporation taxpayer (a corporation that is not a subchapter S and pays tax as though operating as an individual) that has a sizeable profit, a father-son ownership team, and reports for tax purposes on the cash basis method of accounting. Suppose that Daddy has aspirations of retiring in the not too distant future. Try this one on for size. For the current year, why not allow the Company to pay tax on $75,000 of income.

By leaving this amount of taxable income inside of the C Corporation, the 15% and 25% tax brackets will be exploited. The father -son owners have a much higher marginal tax rate facing them-35%. By doing it this way, we save money within the corporate structure allowing it to stockpile additional capital to manage operations going forward. The earnings exceeding the $75,000 of desired taxable income will be paid out to father-son in the form of bonus or other compensation.

In addition, the Company will make a profit sharing plan contribution on their behalves. This is a great tactic for this Company's year end tax planning as the lower corporate rates are used for maximum benefit and the owners (father and son) get tax sheltered income in the form of retirement plan contributions. The business now has working capital as we approach another year of operations.

As for a strategic financial consideration, if Father is considering retirement in the not too distant future, why not consider gifting the stock to qualified small business trust, where sonny is the beneficiary, in January (the next year of operations). The Company would then make a corresponding S corporation election (due by March 15th for calendar year corporations-use form 2553). A gift tax return will have to be filed by father and a valuation will need to be performed on the gifted shares.

The valuation of these shares will consider the time frame of the gift to the trust and its earnings potential. If father will strip most or all of the earnings and the gift term is say ten years (the recognition period for the S corporation, when it is converted from a C corporation, in order to avoid liquidation tax), the value of the gift will be significantly reduced thus preserving the estate tax exemption for other assets in his estate. The gift tax return is filed on form 709 and is due by the filing of Father's personal income tax return.

For those of you more advanced, when converting a C corporation to an S corporation, income is recognized at the corporate level to the extent of unreported receivables and payables, the 481(a) adjustment, because of using the cash basis method of accounting for tax reporting purposes. Remember, a major trait of the S corporation involves the flow-through of profits to the shareholders, thus avoiding corporate level tax. Regarding cash basis C corporations converted to S corporations, the would-be taxable income of the entity would have to be eliminated to avoid a corporate level tax.

This would be true for the entire ten year recognition period. Because it would be the goal of the corporation to eliminate taxable income, in order to reduce the exposure to gift tax consequences, we have effectively killed two birds with one stone. There will be no corporate level tax; the corporation can continue to use the cash basis method of accounting, and Father will have a limited exposure to estate and gift taxes. Wait a minute, that's three birds with one stone. Nice.

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